The German constitutional court, the Dutch electorate and the US Fed all played their part. But it was the supposedly terminally paralysed government’s one-two punch last week that turned the dark potion in which the economy was wallowing into wine. Dr Subbarao’s cash reserve ratio (CRR) cut on Monday, in an elegant pas de deux, turned the wine to champagne.
Sentiment turned sharply, and while some fear rollbacks and worse, the reality is that the government will find it much easier to sustain its focus on fiscal consolidation and growth since it has recognised that it really has no meaningful opposition, only die-hard objectionistas who flounce around their fake anguish and frothy viciousness.
The rupee, of course, jumped smartly, recovering some of its sentiment-driven weakness against the dollar. However, while the DXY has lost nearly seven per cent from its peak by September 17, the rupee has only gained about 5.5 per cent against the dollar over this time. Thus, the rupee may still have a little upside.
In parallel to this move, the correlation of USD/INR with the DXY has been rising. The long-term average of the correlation is around 50 per cent, which means the rupee moves in concert with the global market about half the time. It is currently at 61 per cent, up sharply from near zero just a few days ago. This suggests that domestic volatility could continue to climb as it gets more in sync with the global market.
To my mind, this would be a good thing. Till these last moves, the market had become extremely quiet, as a result of which the volume of unhedged short exposures was increasing. While cognisant of the fact that – to quote Mr Padmanabhan, executive director of the Reserve Bank of India (RBI) – “…any stability over an extended period of time could be a harbinger of volatility”, it is very difficult for corporate treasurers to justify buying forward when the rupee’s movement over the past three months showed a standard deviation of just 33 paise against an average three-month cost of hedging more than three times that (1.02).
With the rising volatility, the standard deviation is already at 42 paise and climbing. Together with a much better spot level for imports, I would imagine there will be more hedging on both sides of the market.
Going forward, while there is, as I mentioned earlier, some more room for rupee strength, particularly if the government confirms its leadership strongly, global events will also exercise considerable impact.
The Eurocrats appear to have, to their resounding credit, won the most recent battle with markets — note, particularly, the results of the Dutch elections where “the Liberal and Labour parties, which backed euro-zone rescue packages over the past two years, saw their shares rise to levels neither had reached in more than a decade”. This could underpin the euro’s correction for some time, which could help the rupee hold firm.
However, as was brilliantly articulated by George Soros in a speech in Berlin a couple of weeks ago, the fundamental problems of the euro zone – primarily the widening gap in competitiveness between the “core” and the “periphery” – remain unaddressed. Mr Soros called upon Germany to “leave or lead”, both of which look tricky at this time. The next time the European agenda stumbles, the current QE-forever fuelled risk-on could hit a wall and the dollar bull trend could reassert itself, perhaps savagely.
Thus, the threat of 55 to the dollar (or worse) remains in place, so short dollar exposures should be prudent, particularly as premiums have started to ease a bit. A little hesitantly, I would forecast a range of 52.50 to 55 for the rest of this year.
In any event, the RBI should be looking at loosening some of the constraints it put on the market to contain volatility. Not only would the increased volatility drive more companies to hedge on both sides of the book, but more deregulation would also be of a piece with the new Reforms 2.0 agenda.
With the stock market looking reasonably good, the disinvestment should go smoothly; this would help the deficit and, importantly, get some of the still grouchy analysts closer to believing. And, given that everybody – particularly shifty politicians – loves a winner, the Congress may be able to bring more and more recalcitrant “allies” into line for, say, a push on the goods and services tax.
I’m going shopping — it may soon be time for champagne and vada pao all over again!
